Does a reverse mortgage ever make sense?

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By Jeff Wuorio, Deseret News

You’ve probably seen the ads with celebrities praising the benefits of reverse mortgages for cash-strapped seniors.

A recent one features actor Henry Winkler explaining how older Americans can tap into the equity of their homes to help meet expenses.

Does a reverse mortgage ensure financially Happy Days?

“The truthful answer is that it depends, based upon the individual homeowner's circumstances, needs and financial resources,” said Steven A. Bogan of Glendenning Mortgage Corp. in Haddonfield, New Jersey. “For example, a person that needs to pay for home health care professionals but does not have the income to absorb this expense could be an ideal candidate for a reverse mortgage.”

But the need for cash is just one reason to look into a reverse mortgage. There are associated short- and long-term costs that should be considered in determining whether a reverse mortgage is the best option for you and your heirs.

Reverse mortgages explained

A reverse mortgage allows homeowners to access the equity in their homes without selling. To qualify, applicants must meet various criteria, including:

Be at least 62 years old.

The home must be their primary residence.

The applicant must have paid off most, or all, of their “traditional” mortgage (although, if there’s an outstanding balance on the conventional mortgage, a reverse mortgage may be used to pay that off.)

The attractive distinction of a reverse mortgage is that it that does not need to be immediately repaid by the borrower. Instead, the loan can be repaid when the borrower leaves the home and the house is sold. Although similar to a home equity line of credit, a reverse mortgage doesn't require any monthly payments to the lender — a plus for older people often on a tight budget.

Applicants can receive mortgage proceeds in a lump sum or in regular installments.

Reverse mortgages are available through private firms. Federally insured reverse mortgages, known as home equity conversion mortgages, are available through a Federal Housing Administration-approved lender.

“The FHA has taken quite a few steps in the past few years to make reverse mortgage loans safer for borrowers, such as protection for surviving spouses,” said Aaron LaRue of the website Mortgage Monks. “They’ve also added a financial assessment to the loan product, which means the loans are harder to qualify for.”

Reverse mortgage pluses

Among the other advantages of reverse mortgages is homeowners remain in their homes while retaining exclusive title and ownership. Moreover, because payments are considered a type of loan and not income, the proceeds are not subject to tax. Nor does a reverse mortgage impact Social Security or Medicare benefits.

Another advantage is the flexibility with which reverse mortgage proceeds may be used. For some borrowers, funds can serve as a financing supplement that may be applied to everyday expenses for retirees who may not have saved enough to maintain a desired lifestyle.

In other instances, reverse mortgage funds can be targeted toward a specific, one-time use, such as an unplanned medical expenses.

“The biggest pro with a reverse mortgage is it can reduce your housing expenses and provide long-term monthly income,” said LaRue. “This might be the best — or only — option for retirees facing a major income gap or an unexpected major expense, like a medical bill.”

The downsides

Like any other financial product, reverse mortgages are not free of caveats. For reverse mortgages, the main drawback is the expense, which includes lender fees, mortgage insurance (for federally insured loans) and closing costs. Factors impacting overall cost also include the age of the borrower and appraised value of the home.

For instance, a 64-year-old with a home valued at $300,000 can expect to pay more than $8,000 and even more in loan origination fees and upfront costs for a reverse mortgage that accesses the greatest amount of funds available.

The National Reverse Mortgage Lenders Association has a reverse mortgage calculator here.

In fact, fees associated with reverse mortgages are more expensive than they used to be, thanks in part to The Reverse Mortgage Stabilization Act of 2013 — which Congress passed to reduce the number of homeowners unwittingly overextending themselves and becoming unable to pay property tax, hazard insurance and other essential obligations. The higher fees help cover the costs the federal government was paying insurance claims to lenders whose borrowers defaulted.

The legislation cut back the amount of equity homeowners could tap into by roughly 15 percent — in most cases borrowers are eligible to withdraw up to 60 percent of their home’s equity.

Although a reverse mortgage doesn't require immediate repayment by the borrower, interest rates do apply when the loan is eventually paid back. In many cases, reverse mortgages are subject to variable interest rates. Since rates are currently in the 3 to 4 percent range, many feel the only place rates can trend is up, costing reverse mortgage holders more the longer they use and wait to repay the proceeds.

“There are two major cons, and they’re intertwined. The first is the fact that you could end up with no home equity, which means you may not have anything to leave to your family once you’re gone,” said LaRue. “Also, if you choose to receive monthly distributions, you are signing up for an adjustable interest rate. The lifetime caps on these mortgages can be quite high.”

Is it right for you?

The federal department of Housing and Urban Development has a website through which consumers can locate a reverse mortgage counselor.

“As with all financial tools, it is not for everyone, and we always encourage our clients to consult their financial adviser, tax professional and their family,” said reverse mortgage specialist Mehran Aram.

Among the questions to evaluate is how long the homeowners plan to stay in their home.

“They should be pretty sure that they plan to stay in their home for the very long term, hopefully for the rest of their lives,” said Portland, Oregon, financial planner Glen Clemans. “Because the upfront costs are so much higher than a traditional mortgage, (reverse mortgages) generally don't make sense as a short-term solution.”

Consider as well the impact of how much money you may be able to leave your heirs. The more you use from your home’s equity, the less that remains for your loved ones.

Jeff Wuorio lives in Southern Maine, where he covers personal finance and entrepreneurship. He may be reached at jwuorio@yahoo.com and his website is at jeffwuorio.com.

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